Op risk analysis underrates human behaviour – Fed examiner

Employees' behaviour individually and as a group has a crucial influence on successes or failures at companies and yet the human factor is underestimated in operational risk analysis, a regulator says, calling for "a vision of governance in the broadest sense possible".

The implied emphasis on culture by Richard Cech, senior bank examiner in operational risk governance at the Federal Reserve Bank of New York, chimes with comments by Mick Ankrom of Bank of America who says repairing banks' reputations is key to attracting young professionals to business and risk functions in the financial industry.

"What we are doing in operational risk is behavioural science," Cech said at the OpRisk North America conference this week. "We talk about behaviour of organisations, of people in organisations, and much of what we've done in the first 10 years has been treating it as a physical science."

The way people work together within firms accounts for a large portion of differences between organisations, he said, adding: "I've never once in these conferences heard anyone talking about group function as a core driving variable. I think we need to get to that because I think that's the next generation."

Cech suggested applying agent-based simulations, also known as tabletop exercises, to predict and prepare for operational risk scenarios. This type of modelling draws on data and computation tools to examine how independent ‘agents', such as individuals, will interact with one another in a given situation and to forecast the impact of those interactions on the behaviour of the group as a whole.

Cech cited the example of a US government adviser who successfully uses agent-based modelling to establish what would happen if "you take one of the tribal chiefs out in north-western Pakistan, who's going to take over next".

Cultivating the right processes and conduct in a company is essential to preventing operational mistakes and resulting losses, which need to be covered by capital, Cech said.

"Whatever you put aside, the very next quarter you want that same capital to be there at the end of that quarter. If you spend it all on events, you are going to have to replenish it and that's going to become very expensive. So even if you focus on capital, you'll eventually get back to a point where you see it as a behavioural kind of issue."

Ankrom, head of enterprise credit and operational risk at Bank of America, also suggested that misconduct by financial companies had a knock-on effect on what he saw as one of the main challenges facing the industry: competition for talent.

"I've never seen it at a level that I see today," he said. "Frankly, if I'm coming out of college today and I'm reading the headlines for the past five years, I'm not sure how attractive it sounds to work in the banking industry. So I think we've got a reputation that we've got to overcome."

This article initially appeared in sister publication Risk.